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January 11, 2013

What’s Behind FINRA’s Newfound Move on Disclosing Broker Bonuses?

This is a commentary on FINRA's proposed rulemaking on broker bonuses, but first, let's pause to consider the national pastime.

Like many baseball fans, I watched with disbelief as a laughing Alex Rodriguez (benched for poor play) cavorted with fans in the stands as his New York Yankees were getting thumped by the Detroit Tigers in the American League Championship Series last October. A-Rod appeared to have not a care in the world, and why would he? He gets paid no matter how he plays—even if he doesn’t play—and what a paycheck it is: in 2012, he took a cool $29 million to the bank.

But that’s not the worst of it for the Yanks. With five years left on his 10-year, $275 million contract, A-Rod, with a set of damaged hips, and apparently unable to hit the ball out of his shadow, pundits speculate that if the Yanks want to trade A-Rod they may be able to find another team willing to pick up only $5 million of his present salary, leaving the Yanks paying him more than $20 million a year to play for someone else.

While the A-Rod story is the most egregious example--poorly written, outlandish player contracts are pervasive throughout major league baseball--which shows that team owners are not immune from the mass hypnosis that can compel an entire industry into a frenzy of paying superstars unheard-of salaries to take them to new levels of potential profits. While baseball player comp packages have cooled a bit in recent years, MLB has yet to find a solution. Meanwhile, the National Football League solved its salary inflation problem with team “salary caps.” Under the salary cap, there’s a set total amount each team can pay all its players collectively. The genius of the salary cap is two-fold: now, team negotiators can tell players (through their agents), “Hey, I’d love to pay you that, but we just don’t have the money”; and even better, players are conscious that if they demand too much, their team won’t have money to pay other quality players, and to many pro athletes (clearly not A-Rod) losing is worse than not getting paid more.

Sorry for the long preamble, but I thought of A-Rod and the challenges of professional sports as I was reading Melanie Waddell’s Jan. 7 AdvisorOne story “FINRA Advances Bonus Disclosure Plan for Brokers.” I began to wonder, in fact, whether the Wall Street firms had gotten caught up in a similar “bonus” frenzy. If so, perhaps this recent focus on broker recruiting bonuses contained some kind of a clever solution to their problem. That is, the problem with a recruiting frenzy is that one firm can’t simply just say no: their competitors will end up with all the superstar brokers. To solve the problem, all the firms have to work together, but not collectively (otherwise they’ll run afoul of restraint-of-trade laws). However, if they could create a disincentive for brokers themselves demanding higher, that just might work.

I found a very informative article on Reuters.com by Jed Horowitz last April with the headline, “Broker Bonus Bidding War Comes at a Cost.” Here’s how Horowitz described the situation: “The brokerage arms of banks such as Morgan Stanley, UBS AG, Wells Fargo & Co. and Bank of America are offering high-end U.S. brokers two to three times the commissions and fees they produced in the previous year, up from about one times those earnings previously. The bonuses, which can approach $15 million for some teams over several years, have steadily escalated, recruiters say. The big companies are eager to attract big brokers and assets at a time when investors are still fearful of investing and cutting down on trades. So despite the costs, big firms keep bidding up the pay.”

Horowitz went on to offer a most interesting quote by Alois Pirker, research director of industry consultant The Aite Group in Boston: "Clearly they want the deals to go away, but no one can afford to make the first move and lose market share." Just so.

Now I know this will sound cynical (over the years, I’ve found that when one is dealing with Wall Street, cynicism is often the preferred mental state), but what better way to make these recruiting bonus deals “go away” than, under the guise of working toward a fiduciary-like standard, require that brokers disclose them to their clients? In this climate of vilifying the “1%,” how many clients are going to understand a $15 million bonus to change firms? How many brokers are going to be willing to take that risk?

Too cynical?

Consider: How many revenue streams do brokerage firms have—either a broker’s new one or their old one—stemming from a client’s accounts? How many of those does the newly “fiduciary conscious” FINRA require to be disclosed to clients? Hmmm. Perhaps Wall Street, like the NFL, has indeed found a solution to its signing bonus frenzy. If only A-Rod were a broker…

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